The market's making a comeback this year after falling into a bear market in 2022. Some still don't officially call it a bull market, but the Nasdaq Composite is up more than 20% from its lows, so the Nasdaq could be understood to be back in bull territory.
But should you invest after the run-up in the Nasdaq's value? The intuitive answer is yes; if the index is on its way up, investors want to take part in that. But the contrarian response would be to take a step back. Let's see if it's a safe option right now.
Why is the Nasdaq higher this year?
The Nasdaq Composite is an index of stocks on the Nasdaq Stock Market. It acts as a window into what's going on in the market, like the Dow Jones Industrial Average or the S&P 500.
Each of these indexes gives a different glimpse into how the market is doing. The Nasdaq is tech-heavy, so its performance won't necessarily mirror movements in other market indicators. Last year, when there was a flight to safety in the wake of soaring inflation, all of these indexes lost value. But the safe-stock-heavy Dow Jones performed the best, while the growth-stock-heavy Nasdaq performed the worst.
This year, as investors feel more secure in the economy's strength, and they return to tech stocks and growth stocks, that's flipped.
When is it safe to invest in the Nasdaq?
What you'll notice from the above charts is that the Nasdaq typically moves at more extreme rates than the overall market. It's made up of many growth stocks, which are often riskier than established and value stocks.
That brings us back to the theory of why an investor might not want to partake in an ascending Nasdaq market. The risk is that it gets too high, stocks become overvalued, and then it's bound to move in the other direction -- in an extreme way.
Image source: Getty Images.
The average price-to-earnings ratio of the Nasdaq-100, a weighted index of the 100 largest Nasdaq stocks by market capitalization, is 30. That's up from 23 a year ago, which makes sense considering that the index is up 40% over the past year. According to data from The Wall Street Journal, that valuation is expected to fall to to 26 within the next 12 months. That could mean one of three things: prices will fall, earnings will rise, or both. That's also only an expectation; there's no guarantee of that happening.
Should you invest in the Nasdaq right now?
The Nasdaq Composite has about 2,500 stocks, so its movements are an average. You might decide that one particular stock has a better combination of performance, valuation, potential growth, and other factors than another stock. Even so, it's important now to place some additional emphasis on valuation, since some Nasdaq stocks are likely to be overvalued right now.
If you're considering investing in a Nasdaq Composite or Nasdaq-100 index fund or exchange-traded fund, you might want to wait for a better entry point. If you have a long-term horizon, you should still take that into account, but it's less of an issue.
